A private company by the name of EM has the following capital structure: Debt Capital Equity...
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A private company by the name of EM has the following capital structure: Debt Capital Equity Capital $1,000,000 Total Value $3,000,000 Cost of Debt 6.5% $2,000,000 Beta Value 1.3 (1.1). Using the above information calculate EM's percentage of equity and debt capital. [2 marks] (1.2). Using CAPM and the information in the table, calculate EM's cost of equity. The risk free rate and rate of return on market are 4.5% and 18% respectively. [5 Marks] (1.3), Calculate EM's weighted average cost of capital (WACC). EM pays 30% tax. [6 Marks] (1.4). EM's $2,000,000 loan (debt) is for 20 years. Using the above information calculate annual repayment on EM's loan. Use after tax cost of debt as interest rate. [6 Marks] (1.5). Calculate EM's present value (PV), net present value (NPV) and internal rate of return (IRR) using the net cash flow after loan repayment. Use WACC as the discount rate. Other information over the 10-year period are as follows: Before loan repayment cash flows for first 2-years are $200,000 per year, next 3-years are 300,000 per year, and next 4-years are $400,000 per year. In year 10 the EM is expected to be sold for $4 million and in same year the balance loan will be paid off. So year-10 net cash flow is sale price minus the balance loan payment. Loan repayment starts in year-1 and you may round off yearly loan repayment figure for simplicity. For year zero the upfront cost is $1,000,000 which is owner's equity. [15 Marks] (1.6). Will you invest in the EM? If yes why; if not why? Also calculate return on equity capital to better explain your answer. [6 Marks] In question one you have calculated EM's PV, NPV and IRR. However, you are not sure whether these values are maximised given your capital structure in question one. Therefore. using the information in the table below, change EM's capital structure and evaluate which debt/equity mix maximizes EM's PVs, NPVs and IRRs. Annual net cash flows and 30% corporate tax remain same as in question one. Equity 0.20 0.50 0.80 Debt 0.80 0.50 0.20 Cost of Equity 35.0% 13.0% 11.5% Cost of Debt 5.5% 7.0% 7.5% Calculate respective PVs and NPVs for each debt/equity mix and show, out of the three, which mix (capital structure), maximizes EM's values. Also explain how the values are maximised. A private company by the name of EM has the following capital structure: Debt Capital Equity Capital $1,000,000 Total Value $3,000,000 Cost of Debt 6.5% $2,000,000 Beta Value 1.3 (1.1). Using the above information calculate EM's percentage of equity and debt capital. [2 marks] (1.2). Using CAPM and the information in the table, calculate EM's cost of equity. The risk free rate and rate of return on market are 4.5% and 18% respectively. [5 Marks] (1.3), Calculate EM's weighted average cost of capital (WACC). EM pays 30% tax. [6 Marks] (1.4). EM's $2,000,000 loan (debt) is for 20 years. Using the above information calculate annual repayment on EM's loan. Use after tax cost of debt as interest rate. [6 Marks] (1.5). Calculate EM's present value (PV), net present value (NPV) and internal rate of return (IRR) using the net cash flow after loan repayment. Use WACC as the discount rate. Other information over the 10-year period are as follows: Before loan repayment cash flows for first 2-years are $200,000 per year, next 3-years are 300,000 per year, and next 4-years are $400,000 per year. In year 10 the EM is expected to be sold for $4 million and in same year the balance loan will be paid off. So year-10 net cash flow is sale price minus the balance loan payment. Loan repayment starts in year-1 and you may round off yearly loan repayment figure for simplicity. For year zero the upfront cost is $1,000,000 which is owner's equity. [15 Marks] (1.6). Will you invest in the EM? If yes why; if not why? Also calculate return on equity capital to better explain your answer. [6 Marks] In question one you have calculated EM's PV, NPV and IRR. However, you are not sure whether these values are maximised given your capital structure in question one. Therefore. using the information in the table below, change EM's capital structure and evaluate which debt/equity mix maximizes EM's PVs, NPVs and IRRs. Annual net cash flows and 30% corporate tax remain same as in question one. Equity 0.20 0.50 0.80 Debt 0.80 0.50 0.20 Cost of Equity 35.0% 13.0% 11.5% Cost of Debt 5.5% 7.0% 7.5% Calculate respective PVs and NPVs for each debt/equity mix and show, out of the three, which mix (capital structure), maximizes EM's values. Also explain how the values are maximised.
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1 Equity and Debt Capital Calculation Equity Capital 3000000 Debt Capital 2000000 Percentage of Equi... View the full answer
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
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